Five reasons the China 'currency crisis' is a beat-up

By Malcolm Maiden

This week's slide in the value of the yuan doesn't bear comparison with real currency crises. Here are five reasons why:

1. Compared with a real crisis, it doesn't rate

At its worst, the yuan was down about 3.5 per cent against the US dollar this week. It was rising on Friday, trimming the loss to about 3 per cent. That's not a currency crisis, or even a currency shock. Here are some samples of the real deal.

China's currency moves rocked.Credit:Reuters

★ In September 1992, Britain tried and failed to defend the pound against selling by hedge fund operator George Soros and other traders. The sellers knew that the pound's value had been fixed too high when Britain entered the European Exchange Rate Mechanism (ERM) , and sharply higher British interest rates did not deter them from selling. The pound slumped 15 per cent in a week, Britain was forced to exit the ERM, and George Soros banked a $US1 billion profit.

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★ In 1994, the Mexican government abandoned a currency alignment, or peg, with the US dollar that had pushed the peso too high, and encouraged capital flight to the stronger US economy. The peso's value halved, triggering heavy inflation, a recession, bank collapses and an International Monetary Fund-led bailout in 1995.

★ In the 1997 Asian Financial Crisis, the Thai baht depreciated 40 per cent, the Korean won fell 34 per cent and the Indonesian rupiah fell about 80 per cent.

★ Argentina pegged its currency to the US Dollar at a one-for-one exchange rate in 1991 and hoovered up private and public sector debt for almost a decade, even as its overvalued currency sowed the seeds of a protracted recession by making the economy uncompetitive. Faced with massive capital flight and bank runs, the government unpegged the peso in January 2002, and it lost about three-quarters of its value. The devaluation made Argentinian exports competitive again, and the economy returned to growth in 2003.

2. The yuan was overvalued, and still is

The US dollar has been rising as America's economy strengthens and the US Federal Reserve prepares to lift interest rates, and China's US-dollar peg has until this week meant that the yuan has been moving in lockstep.

Both currencies had risen about 28 per cent against the Australian dollar since early September last year, ahead of this week's decision by China's Central Bank, the People's Bank of China (PBOC), to loosen the tie between the yuan and the US dollar. They had risen about 20 per cent against the euro, 25 per cent against the yen, and 12 per cent against the Korean won.

Currency appreciation hurts international price competitiveness and puts a brake on economic growth, and while the US is growing quickly enough to make a rate rise this year a virtual certainty, China's currency overvaluation problem is more pressing.

A strong yuan does reduces the price of the things China imports, and increases the prices of the things it exports. It helps China's economy move towards a developed-economy mix of growth by encouraging domestic consumption, and that is something the Chinese government wants to see.

A decline in the yuan that touched the brakes on that transition makes sense, however, if it improves the price competitiveness of Chinese exporters and boosts economic growth overall.

It could also help arrest a flow of capital overseas that has pushed China's capital account into deficits this year as companies and investors cash in on the abnormally high yuan to invest money abroad.

Perceptions of where the yuan is headed will, however, be important: The PBOC said this week reports that the yuan was down 10 per cent were nonsense, and has been intervening in the market to buy yuan this week if selling becomes intense. Its intentions are not totally clear, however, and if Chinese companies and individuals believe the yuan is headed lower they will consider accelerating overseas investment, to capture the higher yuan exchange rate while it lasts.

3. Allowing the yuan to trade more freely is the right thing to do

The PBOC sets the yuan exchange rate daily, and the currency is allowed to trade up and down within a band between each currency fix. The central bank was ignoring the market's price signals until this week as it tracked the US dollar. In what it calls the new normal, it is now reflecting the market moves in its price fixes.

This makes the yuan more market-based. It is one of the steps that has to be taken if China is to integrate its economy with the global financial system, and makes it more likely, for example, that the yuan will join the yen, US dollar, Euro and the British pound as one of the world's reserve currencies, something China's economic weight in the world already warrants.

4. China has considered the West with its timing

The decision to change the way the yuan's exchange rate is set and take more account of market trading was described as a surprise but it was, if anything, overdue: The yuan's strength has been complicating China's economic management all year, and the June-July sharemarket shivers may have delayed the move.

The change has also probably been announced now to get in ahead of the first US rate rise for nine years, either next month or in December.

Next month is still considered the most likely launch date, although the US dollar's rise this week as the yuan declined was negative for US economic growth, and might persuade the Fed to wait.

Either way, China has created some room for the markets. It is easier for them to digest the yuan change and a rate rise in the US separately.

5. A lower yuan is not all bad news for the West

You would think it was, reading this week's stories, and it is true that a weaker yuan makes Chinese manufacturers more price-competitive in their export markets, including Australia. It also makes exports to China more expensive.

Talk of "currency war" is overblown so far, however, and Chinese exporters are actually still hampered by the yuan's strength. Australia will gain more than it loses if a lower yuan boosts China's economy and commodity prices.